Taxing China

Pay and play

One year on, China’s most-hyped tax is still mostly hype

THE vast city of Chongqing in south-west China is famous for its hills, which punish the knees, and its skyline, which strains the neck. The metropolis, straddling the Yangzi river, is sprawling outward as well as upwards (see picture), and its municipal government is keen to capture more of the value created by its rapid development. A year ago it pioneered a tax on large single-family homes and new luxury flats. Some 1,400km (870 miles) downstream, Shanghai also imposed a tax on luxury second apartments.

Such property taxes are common elsewhere in the world, championed by economists, resented by homeowners. But in China, they are a novelty. Advocates argue that such taxes could ease two of China's biggest economic problems. The first is the speculative fever that so often grips the housing market. The second is the debt that troubles local governments.

This debt reflects China's peculiar division of fiscal revenues and responsibilities. The constitution, in an intriguing phrase, promises to give “full play to the initiative and enthusiasm” of the country's local authorities, but its fiscal arrangements give them little to play with. In 2010 local governments accounted for over four-fifths of public spending but collected just 45% of the country's tax revenues, a gap amounting to 4.1 trillion yuan ($600 billion) or just over 10% of GDP.

Handouts from the central government fill much of that gap. Meanwhile, local governments' favourite source of cash lies underfoot. In 2006-10 across China they sold land-use rights to over 22,000km2 of land, an area the size of New Jersey.

Such sales are lucrative, but also divisive. Urban land in China belongs to the state, whereas rural land is owned “collectively”. This hazy definition lets officials use their power as representatives of the state to displace villagers on the urban fringe. Officials pay the farmers compensation on the basis of the land's agricultural value, whereas developers buy the land at a price nearer to its commercial value. So city governments profit at the expense of villagers. The shenanigans provoked a remarkable uprising in the small southern town of Wukan in December, and protests happen elsewhere almost daily.

To calm rural discontent, larger cities now offer more generous compensation, Joyce Yanyun Man of Peking University says. But the property market is slowing and sales are faltering. That will make it harder for local governments to repay the huge debts they incurred during the stimulus programme of 2009-10, when the central government urged state banks to lend to local governments in order to stave off the effects of the global financial crisis. Localities now have a pressing need to find other sources of revenue.

China already imposes taxes on property—as many as a dozen, according to Bo-sin Tang of Hong Kong Polytechnic University. But most cover the buying or selling of it. None reflects its market value or falls on the most common form of property: homes. The taxes therefore make a paltry contribution to local coffers.

China's government has talked about introducing a fully fledged tax on home ownership since 2003. What has stopped it? The logistical barriers should not be underestimated, says Mr Tang. The government must clarify who owns what, and decide what a property is worth. Fair valuations need expertise and independent judgment—both in short supply in China. Unfair valuations, on the other hand, will breed resistance and evasion, which China already has in abundance.

But the biggest obstacle is political. Most urban residents own their home. Some, including many party officials, own several. For them, a property tax would be a levy not on their home, but on the wealth they have locked up in property that often lies vacant. The Communist Party does not want an angry middle class.

These political sensitivities are apparent even in the pioneering cities. Chongqing, for example, charges a puny rate (0.5-1.2%) on a tiny number of properties—barely 8,500, according to Xinhua, the state news agency. The much-ballyhooed experiment netted just 90m yuan in its first ten months, less than 0.2% of Chongqing's tax revenue.

To put a lid on property speculation and plug the hole in municipal finances, China's property taxes will have to cover more homes in more cities. None has yet volunteered, though faltering land sales may give them a prod. And some cities might take the plunge if the central government offered to lift the curbs it has placed on property speculation. In the realm of property taxation, alas, China's local authorities have shown neither initiative nor enthusiasm.